The taxman cometh four extra
times a year for some filers
By Kay Bell • Bankrate.com

Did you just sell that hot stock and make a tidy profit?

Don't spend all the cash. Some of it has to go as estimated tax payments to the Internal Revenue Service.

These four extra tax filings are the bane of an increasing number of Americans: People who are making money on investments, operating their own businesses or getting any extra cash that doesn't have taxes taken out.

Time consuming? Yes, nobody really likes doing taxes more than once year.

Confusing? Sometimes, especially if you're earning income from several different sources at different times.

Necessary? You bet, or you could end up owing Uncle Sam penalties and interest.

The reason behind estimated taxes
Most taxpayers meet their tax obligations through paycheck withholding.

But if you're self-employed, either as your main job or as a sideline, you must get the taxes on this money to the IRS yourself by filing Form 1040-ES. Estimated taxes also are due on interest and dividends, profits from investment sales, alimony, rental income, and prizes or awards.

The estimated tax system was designed to ensure that taxpayers who have a lot of non-withholding income pay into the tax system regularly. This evens things up between these taxpayers and wage earners who lose a chunk of money each paycheck to taxes.

And while most taxes still arrive at the IRS via payroll withholding, more and more taxpayers recently have found that they must worry about estimated taxes. A growing number of new estimated tax filers are those who have done well in the stock market.

More filers falling into estimated ranks
"Over 50 percent of Americans are invested in the stock market, buying and selling and making a profit," notes Linda Durand, a CPA with McQuade Brennan in Washington, D.C. "And there's a tax on that."

The problem, Durand says, is too many of these folks, excited about their windfall, immediately take the proceeds and spend them without any thought to the tax implications.

That's not a good idea. If you end up owing $1,000 or more in April, the IRS could add penalties and interest to your tax bill for not paying tax on your earnings as you got them.

Instead, Durand recommends setting aside a portion of the new cash for the taxes. And get ready to send it in before the spring tax deadline, she notes, because "the IRS wants people to be paying their taxes during the year."

Estimated filing schedule
To meet the pay-taxes-as-you-earn goal, the IRS has set up an estimated tax timetable calling for the filing of a 1040-ES voucher four times a year.

Although the payments are called quarterly, they don't coincide with the calendar quarters. The IRS estimated quarters and billing dates are:

Meeting the IRS requirement
But Eva Rosenberg, an enrolled agent and the Web's TaxMama.com, offers an alternative to the IRS paperwork if you expect your taxable income to be the same or higher than it was last year.

All you need is last year's tax return and statements showing current tax withholding:

Many taxpayers opt for the safe harbor payment because it protects them from penalties and interest regardless of how high their final tax bill goes.

Some safe tax harbors tougher to navigate
The safe harbor is little choppier, however, if you make a lot of money.

If your previous year's adjusted gross income was more than $150,000 (for both married couples filing jointly and single taxpayers) and you want to base your estimated tax payment on the prior year's amount, you'll have a higher safe harbor percentage to meet.

Congress tends to adjust this percentage each year. For high-earning estimated filers in 2000, the estimated filing target is 108.6 percent of your 1999 tax bill. That means that if your adjusted gross income in 1999 was $155,000 and you ended up with a $50,000 final tax bill, your estimated and withholding tax payment safe harbor for 2000 would be $54,300.

"With both in a couple earning or people holding multiple jobs, the salary cap is not as out of reach as it may seem," notes Durand, "especially if they had a good investment or sold a piece of investment property during the year, too."

A large estimated tax bill can take a big bite out of even a wealthier earner's wallet, in spite of being spread out in four payments.

But there is a way to postpone, if not avoid, the tax pain.

Paying only when you earn
Although the IRS will always take your money early, you don't have to make estimated tax payments until you have income on which you will owe the tax.

So if most of your untaxed income comes in one quarter (like stock dividends paid at year's end), or you operate a business where income fluctuates throughout the year, you should consider paying your estimated taxes under the annualized income system.

"The annualized method allows you to take a look at each quarter independently and pay the tax in the quarter that you earned it," explains Durand. "Say your job is one where most income is in the summer, such as landscaping, rather than the winter. You want to pay the taxes when you have the money."

With this approach, your required estimated tax payment for one or more periods may be less than the amount figured using the four-equal-payments method. To find that out, you'll have to complete an IRS worksheet. Sole proprietors also need another worksheet to determine annualized self-employment taxes that are included with the estimated payments.

And you'll need to file Form 2210 with your annual return, says Durand, to explain why you didn't send in the expected equal payments. This will keep the IRS, which assumes you earned the money equally during the year, from charging you an underpayment penalty and interest for not paying enough in a particular filing quarter.

"It is a little more complicated," Durand concedes. "But for cash flow, it's better and it puts the tax in the quarter when it is earned."

A way to avoid estimated filing
Does the prospect of struggling through worksheets and filing even more tax returns make your head spin? There is an alternative.

If you have wage income in addition to untaxed earnings, file a new W-4 at work and ask your boss to start taking out more payroll taxes to cover any shortfall.

Your take-home pay will be a bit lighter, but you'll be off the hook for estimated tax payments.

-- Posted Sept. 6, 2000